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Action
We reiterate our REDUCE rating on Hindustan Unilever as higher input prices,
continuing heightened competitive activity and limited pricing power means
profitability is likely to come under severe pressure over the near term. We are
cutting estimates marginally for FY12 but increasing our PT to Rs232 from Rs222
on account of a roll forward of our EPS estimates.
Catalysts
Raw material prices at current levels and increasing ad spending over the next
quarter are likely to hurt profitability in the near term.
Anchor themes
We prefer food vs HPC within the FMCG space over the longer term, as the food
space in India is underpenetrated and offers solid long-term growth. Consumer
sector growth is likely to be led by the food subsector, while HPC segments are
likely to lag.
Margin pressures evident
Margins to come under pressure in near term
We believe that over the next couple of quarters HUVR is likely to
face significant margin pressures on account of rising input costs and
inability of the company to pass on the rise in prices to consumers. In
H1FY12, we expect profitability to hit its lowest level in 25 quarters.
Input prices have seen a sharp rise
Input costs across the board have seen a sharp increase, with key
inputs such as LAB and palm oil seeing inflation of 12-37%. We
expect some moderation in input prices in H2FY12, and if this does
not come through, margins could decline in FY12 vs our current
expectation of flat margin performance.
Price increases not enough; A&P to remain high
The company has taken price increases across the portfolio, which
has helped to partially offset the input cost pressures. However, in the
HPC categories, pricing power is limited, in our view, and hence
impact on margins is likely to continue. Additionally, A&P spending is
likely to remain high in H1FY12, putting further pressure on margins.
Cutting estimates
We are cutting our estimates for FY11 and FY12 marginally to
account for higher input prices. We now expect the company to
increase profits by ~12% each year over FY12 and FY13. This is at
the bottom end of our coverage universe.
Reiterate REDUCE rating
We reiterate our REDUCE rating on the stock, although our PT moves
higher to Rs232 on account of a roll forward of our estimates. The
stock still offers 16% downside from current levels. Switch to ITC in
the large-cap space.
Drilling down
Cutting FY12 estimates by 3%
We are marginally reducing our estimates for FY11 and FY12 to take into account the
recent rise in oil and input prices. We believe the company’s strategy of taking
‘judicious and calibrated’ price increases effectively means the focus continues to be
on building the customer franchise, with near-term profitability being seen as
something that can be sacrificed.
The company has been following this policy for the past few quarters, which has had
the desired impact of strong volume growth, with profitability coming under pressure.
We believe in the near term the company will continue to follow this approach despite
input costs pressure being significant.
We do acknowledge that the company has introduced two price hikes, totalling a
weighted average 5%, which should help offset some of the pressure from rising input
costs, but will not be enough to maintain gross margins, in our view.
We now incorporate a soft Q4FY11 into our numbers and expect margins to remain at
the same level in FY12 as in FY11 vs our earlier expectation of a 40bps improvement.
This leads to 2.8% cut in our FY12 numbers.
Introducing FY13F numbers
We are also introducing FY13F numbers. We expect company to grow revenues by
10.6% and margins to improve by 20bps from the FY12F level. While our expectation
is that competitive intensity will continue to remain high, there will be some moderation
in input costs, which will help improve margins. We are building in a 12% improvement
in net income for FY13F, similar to the level in FY12F.
Where are we versus consensus
We are building in a scenario where margins decline sharply in H1FY12 followed by a
recovery in H2FY12, but for overall margins to remain at the same level on a y-y basis
vs FY11. Consensus is building in a significant margin improvement in FY12 followed
by a flat margin profile in FY13. We believe that is unlikely to be the case, as input
costs pressures are going to be a significant hit to the company, certainly in H1FY12.
We are 5% lower than consensus on our FY12F, and believe consensus numbers will
drift lower over the course of the next couple of quarters as quarterly earnings will
clearly demonstrate significant pressure on margins across the HPC space.
Cost pressures evident – to hit P&L over the next 2 quarters
Input prices have continued to move up significantly since the start of the year. Palm
oil prices have continued to rise over the past few months and are now touching
MYR3,629/MT, up 37% from average levels of CY10. LAB, the other key ingredient for
the manufacture of soaps, is up 12% from the average CY10 level. The recent
increase in prices have not been factored in by companies and hence the price hikes
taken at the end of last year will not be enough to offset the latest round of commodity
price increases.
We believe Q4FY11 will see the impact from prices which were prevailing at the end of
Q2/Q3 FY11, as most companies have forward cover of 1-2 quarters for majority of
their raw material costs. This, in essence, means current prices will only be reflected in
Q1/Q2 FY12, and hence margin pressures will remain over the next few quarters
across companies.
Quarterly performance expectations
We are looking at a 60 bps margin decline in Q4FY11, but the full impact of rising input
costs is unlikely to be felt then, in our view. Q1FY12 is the quarter we believe that will
see the worst of the commodity prices if current prices persist. We are looking at a
200bps margin decline in Q1FY12 and for margins to be at their lowest in the past 25
quarters. If input prices remain at current levels, we expect the situation to ease
relatively from Q2FY12, as the company will have time to take further price increases
to offset commodity costs. However, given the nature of the market, we believe price
increases will only be gradual, with the company continuing to focus on maintaining
market share and volume growth in the near term.
We expect the two quarters of H1FY12 to continue to be soft, with volume comps
being high and price increases having a negative impact on volumes. We see recovery
in H2FY12, but overall, we expect margins to remain at the same levels in FY12 as in
FY11. Remember in FY11, we are building in a 150bps decline vs FY10, which means
that for a period of three years, HUL is unlikely to see margin trajectory going back to
previous levels.
We also highlighted in our report ‘Young and hungry’, dated 21 February, 2011, that
margins in the HPC space are likely to face a structural decline, certainly in mature
categories, where HUL has market leadership across various segments such a soaps,
detergents.
We believe margins in the HPC space will see a structural shift downward over the
next few years as the impact of rising input prices, limited pricing power and increasing
competitive intensity in the sector all take a toll on margins. We would point out the
example of the soaps and detergents segment, where profitability has declined
structurally over the past few years. The personal products portfolio has seen
profitability decline significantly from peak levels, but will get weaker, in our view, over
the medium term.
Growth has trended into negative territory
Over the past four quarters, starting March ’10, EBITDA and PAT on a year on year
basis have declined for HUVR. This has been on the back of severe pressure on
margins, which has come down from 16% as at quarter ended December ’09 to 12.4%
as at quarter ended December ’10.
We expect this trend to continue over the next few quarters post Q4FY11 (we expect
EBITDA growth of 23%). For the first three quarters of FY12F we expect EBITDA
growth in the range of -1% to 12%, with PAT growth in the range of -1% to 9%.
Competitive intensity remains strong
Competitive intensity across the FMCG space continues to remain high with several
new launches and re launches planned by companies over the next couple of quarters.
In existing large categories such as the mature HPC space (toothpastes, detergents,
soaps) we see market share gains as the only way to grow as penetration-led growth
is behind us. In the shampoo segment, recent commentary from Dabur suggests
category profitability will come down structurally as competition in the segment
continues to be very high.
We believe companies will continue to invest behind A&P to gain a share of consumer
mind space. Companies may follow different strategies to do this and may not always
be price and promotion led as in the detergents segment last year. Even in the food
space, we see competition remaining high, especially in segments such as instant
noodles, milk and dairy products, chocolates, biscuits. However, the difference here vs
the HPC space is that most of the A&P spends will be in the form of building brands
and gaining mind share of the consumer, which is beneficial for the longer term growth.
Stock has underperformed YTD
Hindustan Unilever has been one of the underperformers YTD. The stock has
corrected by 12.3% YTD vs the FMCG sector -6.3% and Sensex -11.6%. This
underperformance will be starker at -19%, if we consider its performance since its
recent peak of Rs326, touched on 05 January 2011.
We would like to point out that the stock price at current levels is also a reflection of
the support it has got from the buyback programme in place. The buyback is providing
the stock price support below the price of Rs280.
In our view the share price correction is justified as input costs will hit profitability hard
over the next couple of quarters and recent correction is only partly building in the
deterioration in profitability.
Moving price target higher on account of roll forward
We are moving our price target higher to Rs232, on account of rolling forward EPS by
six months. Our valuation methodology remains unchanged at 20x one-year forward
EPS. The price target revision is only on account of rolling forward, even though we
cut our FY12F earnings marginally.
Reiterate REDUCE – maintain as top Reduce call in the sector
Hindustan Unilever remains our top REDUCE idea in the sector. Higher input prices,
increased advertising and promotion spend and low pricing power will mean significant
risk to margins over the next few quarters. We would switch out of HUVR into ITC in
the large-cap space, where margins are expected to improve over the next couple of
quarters on account of limited competition and limited impact from input costs.
We also maintain our preference for the food space vs HPC within the FMCG space,
with Jubilant (and GSK Consumer our picks in the sector at current levels.
Risks
A sharp fall in raw material prices is a key risk to our REDUCE call. However, we see
that as unlikely in the near term, and our estimates only build in a gradual decline post
H1FY12F. Reduced competitive intensity in the domestic market also presents an
upside risk to our numbers
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Action
We reiterate our REDUCE rating on Hindustan Unilever as higher input prices,
continuing heightened competitive activity and limited pricing power means
profitability is likely to come under severe pressure over the near term. We are
cutting estimates marginally for FY12 but increasing our PT to Rs232 from Rs222
on account of a roll forward of our EPS estimates.
Catalysts
Raw material prices at current levels and increasing ad spending over the next
quarter are likely to hurt profitability in the near term.
Anchor themes
We prefer food vs HPC within the FMCG space over the longer term, as the food
space in India is underpenetrated and offers solid long-term growth. Consumer
sector growth is likely to be led by the food subsector, while HPC segments are
likely to lag.
Margin pressures evident
Margins to come under pressure in near term
We believe that over the next couple of quarters HUVR is likely to
face significant margin pressures on account of rising input costs and
inability of the company to pass on the rise in prices to consumers. In
H1FY12, we expect profitability to hit its lowest level in 25 quarters.
Input prices have seen a sharp rise
Input costs across the board have seen a sharp increase, with key
inputs such as LAB and palm oil seeing inflation of 12-37%. We
expect some moderation in input prices in H2FY12, and if this does
not come through, margins could decline in FY12 vs our current
expectation of flat margin performance.
Price increases not enough; A&P to remain high
The company has taken price increases across the portfolio, which
has helped to partially offset the input cost pressures. However, in the
HPC categories, pricing power is limited, in our view, and hence
impact on margins is likely to continue. Additionally, A&P spending is
likely to remain high in H1FY12, putting further pressure on margins.
Cutting estimates
We are cutting our estimates for FY11 and FY12 marginally to
account for higher input prices. We now expect the company to
increase profits by ~12% each year over FY12 and FY13. This is at
the bottom end of our coverage universe.
Reiterate REDUCE rating
We reiterate our REDUCE rating on the stock, although our PT moves
higher to Rs232 on account of a roll forward of our estimates. The
stock still offers 16% downside from current levels. Switch to ITC in
the large-cap space.
Drilling down
Cutting FY12 estimates by 3%
We are marginally reducing our estimates for FY11 and FY12 to take into account the
recent rise in oil and input prices. We believe the company’s strategy of taking
‘judicious and calibrated’ price increases effectively means the focus continues to be
on building the customer franchise, with near-term profitability being seen as
something that can be sacrificed.
The company has been following this policy for the past few quarters, which has had
the desired impact of strong volume growth, with profitability coming under pressure.
We believe in the near term the company will continue to follow this approach despite
input costs pressure being significant.
We do acknowledge that the company has introduced two price hikes, totalling a
weighted average 5%, which should help offset some of the pressure from rising input
costs, but will not be enough to maintain gross margins, in our view.
We now incorporate a soft Q4FY11 into our numbers and expect margins to remain at
the same level in FY12 as in FY11 vs our earlier expectation of a 40bps improvement.
This leads to 2.8% cut in our FY12 numbers.
Introducing FY13F numbers
We are also introducing FY13F numbers. We expect company to grow revenues by
10.6% and margins to improve by 20bps from the FY12F level. While our expectation
is that competitive intensity will continue to remain high, there will be some moderation
in input costs, which will help improve margins. We are building in a 12% improvement
in net income for FY13F, similar to the level in FY12F.
Where are we versus consensus
We are building in a scenario where margins decline sharply in H1FY12 followed by a
recovery in H2FY12, but for overall margins to remain at the same level on a y-y basis
vs FY11. Consensus is building in a significant margin improvement in FY12 followed
by a flat margin profile in FY13. We believe that is unlikely to be the case, as input
costs pressures are going to be a significant hit to the company, certainly in H1FY12.
We are 5% lower than consensus on our FY12F, and believe consensus numbers will
drift lower over the course of the next couple of quarters as quarterly earnings will
clearly demonstrate significant pressure on margins across the HPC space.
Cost pressures evident – to hit P&L over the next 2 quarters
Input prices have continued to move up significantly since the start of the year. Palm
oil prices have continued to rise over the past few months and are now touching
MYR3,629/MT, up 37% from average levels of CY10. LAB, the other key ingredient for
the manufacture of soaps, is up 12% from the average CY10 level. The recent
increase in prices have not been factored in by companies and hence the price hikes
taken at the end of last year will not be enough to offset the latest round of commodity
price increases.
We believe Q4FY11 will see the impact from prices which were prevailing at the end of
Q2/Q3 FY11, as most companies have forward cover of 1-2 quarters for majority of
their raw material costs. This, in essence, means current prices will only be reflected in
Q1/Q2 FY12, and hence margin pressures will remain over the next few quarters
across companies.
Quarterly performance expectations
We are looking at a 60 bps margin decline in Q4FY11, but the full impact of rising input
costs is unlikely to be felt then, in our view. Q1FY12 is the quarter we believe that will
see the worst of the commodity prices if current prices persist. We are looking at a
200bps margin decline in Q1FY12 and for margins to be at their lowest in the past 25
quarters. If input prices remain at current levels, we expect the situation to ease
relatively from Q2FY12, as the company will have time to take further price increases
to offset commodity costs. However, given the nature of the market, we believe price
increases will only be gradual, with the company continuing to focus on maintaining
market share and volume growth in the near term.
We expect the two quarters of H1FY12 to continue to be soft, with volume comps
being high and price increases having a negative impact on volumes. We see recovery
in H2FY12, but overall, we expect margins to remain at the same levels in FY12 as in
FY11. Remember in FY11, we are building in a 150bps decline vs FY10, which means
that for a period of three years, HUL is unlikely to see margin trajectory going back to
previous levels.
We also highlighted in our report ‘Young and hungry’, dated 21 February, 2011, that
margins in the HPC space are likely to face a structural decline, certainly in mature
categories, where HUL has market leadership across various segments such a soaps,
detergents.
We believe margins in the HPC space will see a structural shift downward over the
next few years as the impact of rising input prices, limited pricing power and increasing
competitive intensity in the sector all take a toll on margins. We would point out the
example of the soaps and detergents segment, where profitability has declined
structurally over the past few years. The personal products portfolio has seen
profitability decline significantly from peak levels, but will get weaker, in our view, over
the medium term.
Growth has trended into negative territory
Over the past four quarters, starting March ’10, EBITDA and PAT on a year on year
basis have declined for HUVR. This has been on the back of severe pressure on
margins, which has come down from 16% as at quarter ended December ’09 to 12.4%
as at quarter ended December ’10.
We expect this trend to continue over the next few quarters post Q4FY11 (we expect
EBITDA growth of 23%). For the first three quarters of FY12F we expect EBITDA
growth in the range of -1% to 12%, with PAT growth in the range of -1% to 9%.
Competitive intensity remains strong
Competitive intensity across the FMCG space continues to remain high with several
new launches and re launches planned by companies over the next couple of quarters.
In existing large categories such as the mature HPC space (toothpastes, detergents,
soaps) we see market share gains as the only way to grow as penetration-led growth
is behind us. In the shampoo segment, recent commentary from Dabur suggests
category profitability will come down structurally as competition in the segment
continues to be very high.
We believe companies will continue to invest behind A&P to gain a share of consumer
mind space. Companies may follow different strategies to do this and may not always
be price and promotion led as in the detergents segment last year. Even in the food
space, we see competition remaining high, especially in segments such as instant
noodles, milk and dairy products, chocolates, biscuits. However, the difference here vs
the HPC space is that most of the A&P spends will be in the form of building brands
and gaining mind share of the consumer, which is beneficial for the longer term growth.
Stock has underperformed YTD
Hindustan Unilever has been one of the underperformers YTD. The stock has
corrected by 12.3% YTD vs the FMCG sector -6.3% and Sensex -11.6%. This
underperformance will be starker at -19%, if we consider its performance since its
recent peak of Rs326, touched on 05 January 2011.
We would like to point out that the stock price at current levels is also a reflection of
the support it has got from the buyback programme in place. The buyback is providing
the stock price support below the price of Rs280.
In our view the share price correction is justified as input costs will hit profitability hard
over the next couple of quarters and recent correction is only partly building in the
deterioration in profitability.
Moving price target higher on account of roll forward
We are moving our price target higher to Rs232, on account of rolling forward EPS by
six months. Our valuation methodology remains unchanged at 20x one-year forward
EPS. The price target revision is only on account of rolling forward, even though we
cut our FY12F earnings marginally.
Reiterate REDUCE – maintain as top Reduce call in the sector
Hindustan Unilever remains our top REDUCE idea in the sector. Higher input prices,
increased advertising and promotion spend and low pricing power will mean significant
risk to margins over the next few quarters. We would switch out of HUVR into ITC in
the large-cap space, where margins are expected to improve over the next couple of
quarters on account of limited competition and limited impact from input costs.
We also maintain our preference for the food space vs HPC within the FMCG space,
with Jubilant (and GSK Consumer our picks in the sector at current levels.
Risks
A sharp fall in raw material prices is a key risk to our REDUCE call. However, we see
that as unlikely in the near term, and our estimates only build in a gradual decline post
H1FY12F. Reduced competitive intensity in the domestic market also presents an
upside risk to our numbers
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